The global economy is expected to grow at its strongest pace since 2011; world stock market indices continue to hit record highs; investors seem sanguine despite the prospect of tighter monetary policy, and the dollar remains weak. That’s been the start to 2018.
But will these indicators turn during the course of the year? Does the flat U.S. yield curve point to an impending weakness in growth? Will the dollar turn direction and strengthen as US interest rates rise? And is low volatility making investors, particularly in the fixed income markets, too complacent?
Abby Joseph Cohen, veteran American economist and senior investment strategist at Goldman Sachs, spoke to BloombergQuint about her views on global indicators.
Strong Global Growth
The global economy is expected to grow by 3.9 percent in 2018, according to the IMF’s recently released World Economic Outlook. Cohen believes the growth outlook for the current is a extension of the strength seen in 2017. Goldman Sachs’ own estimate suggests growth of 3.8 percent. “There is not an economy out there that is in recession,” Cohen told BloombergQuint.
What we are seeing out there is something that is very broad based and it is happening in most economies with very low inflation. So it suggests something about the sustainability of this economic expansion.Abby Joseph Cohen, Senior Investment Strategist, Goldman Sachs
Will Inflation Return?
Inflation in the United States remains below the Federal Reserve’s target of 2 percent, despite strength in the economy and tight labour markets. Cohen believes that there are both structural and cyclical factors behind the low inflation. From a structural viewpoint we think there are a few things pushing down inflation, said Cohen.
Some people refer to it as the Amazon effect. I think it is more appropriate to refer to it as the ‘competitive effect’. In an environment where there is good global trade and there are so many companies who have access to computerized distribution systems, we keep inflation structurally somewhat lower than it otherwise would have been.Abby Joseph Cohen, Senior Investment Strategist, Goldman Sachs
Apart from structural factors, cyclical factor such as slack in the U.S. economy have also played a role in keeping inflation low. Some of these cyclical factors are now turning with a drop in unemployment and an increase in wages, said Cohen while adding that two-thirds of business expenses are related to labour costs which are now moving up.
Flat U.S. Yield Curve
Investors, in recent months, have been focused on the flat U.S. yield curve. A yield curve is considered flat when there is scant difference between short-term and long-term interest rates. In theory, this can indicate that bond investors expect growth (and consequent inflation) to remain flat or even weaken. An inverted yield curve, where long-term rates are lower than short-term rates, is often seen as a sign of an impending recession.
Is this time different? Cohen thinks it may be.
We believe the flat yield curve is an indication that there is good demand for intermediate and long term paper and it is not reflective of a problem. I would also point out that there has been a shifting up of the yield curve, in which interest rates at the short end and the long end are all moving up. Also there has been some steepening of the curve. It’s not steep but its not as shallow as it was previously.Abby Joseph Cohen, Senior Investment Strategist, Goldman Sachs
The Weak Dollar
Along with the flat U.S. yield curve, the persistent weakness in the U.S. dollar, too, has come as a surprise to some. The dollar weakened more than 10 percent in 2017 and fell further this week after the U.S. treasury secretary said that a weaker dollar benefits the nation from a trade perspective.
Cohen believes the dollar may have been overpriced by the end of 2016. There was such enthusiasm to own the currency due to concerns around other countries that it was overvalued compared to some other currencies, Cohen said.
What we have seen over the past few months is that there is increasing confidence in the global recovery. The countries that were struggling are doing better economically. What this says is that the dollar is an okay currency but it is no longer necessary to run away from some of the other currencies.Abby Joseph Cohen, Senior Investment Strategist, Goldman Sachs
Dangers Of Low Volatility
Despite global equity indices hitting one record high after another, Cohen believes that markets are not stretched to the point of danger. They are certainly not as cheap as they were though, cautioned Cohen while adding that cheap valuations provide a cushion which may not exist anymore.
Lurking behind headlines of indices surging are concerns about low volatility, which many say cannot last forever. Cohen is one of them. Volatility has been too low not just in the equity markets but also in the fixed income markets, said Cohen.
I am more concerned about the complacency in bond markets than in the equity markets. In the bond markets, we’ve had interest rates around the world that we think are just too low relative to inflation and growth. We do believe interest rates will likely be moving higher.....We believe investors are not prepared for that. They have enjoyed not just low volatility but also rises in bond prices as interest rates have gone down and stayed down. If rates go up, there will be some pain in the fixed income markets.Abby Joseph Cohen, Senior Investment Strategist, Goldman Sachs
Cryptics Of Cyrptocurrencies
Cohen, an economist but also a computer science student, says that she is keeping an ‘open mind’ about this asset class. While there may be something to the underlying ledger system, Cohen says she is more cynical about the cryptocurrencies themselves as these have not yet proven themselves to have the attributes of a ‘currency.’ Cohen, however, believes that there could be utility to these in countries where there is lack of confidence in the national currency.
We also know this. The millennial generation has some skepticism about structures and organisations and institutions. They have more confidence in computer systems. We need to keep that in mind as well. But at present the enthusiasm about cryptocurrencies is being driven by flows of funds rather than the actual use of these currencies.Abby Joseph Cohen, Senior Investment Strategist, Goldman Sachs